My take on politics, economics and liberty. I don't owe allegiance to any political organisation. I have my own ideas. Sort of.

Thursday, 29 October 2015

Tax Credits

Everybody has an opinion on tax credits at the moment. That makes it a great first topic for this blog for the following reasons:

Not knowing anything about the subject is no bar to having an opinion because,

Opinions are largely based on party allegiance or self identified social group membership,

The issue is highly politicised and winning popularity is more important to those who are in a position to do something about than the need to tackle the issue.

It is an issue that needs tackling.

It is a very difficult issue to do anything about.

Don't expect to see much of me telling you my qualifications on here. Argument from authority is weak and I don't do it but in the spirit of disclosure I will say I have previously spent many years in receipt of large sums in tax credits and that I am now an employer.

There are generally two opposing positions from which this is argued about.

Reducing the incomes of people who are "doing the right thing" is unjust.

The country can't afford to carry on as we are.

The problem is, both points of view are exactly correct.

Let's have a look at the way tax credits work so we can begin to consider the issue from a different angle.

Firstly let's look at the big picture: What are the big problems in the UK economy and society?

Poor social mobility

Stubbornly low productivity

Low wages

Tax credits make all these things worse because of the way they work. In case you don't know how they work, here it is in a fairly concise, general form. Claimants estimate their income in the coming year and are awarded tax credits to bring their income up to a certain minimum. Generally the less you earn, the bigger your award; the more children live with you, the bigger your award. If you earn more than you estimated, your claim is reduced by 50% of the amount you earned in excess of your estimated earnings and that amount is deducted from your next year's claim or, if your next year's claim doesn't cover that amount, you have to repay it.

This system makes claimants very careful not to earn more than their estimate, if they have any sense.

Look at it this way: your boss offers you £100 to change the way you work or to work overtime or whatever. Assuming you are earning over £10k per year, your Tax and NI on that £100 will amount to approx £33. Plus it will cost you a £50 reduction in your tax credit claim. So you do £100 worth of efficiency, overtime or whatever and you only get £17 of it. Would you do £100 of work for £17?

That's a marginal tax rate for somebody deemed poor enough to require in-work benefits of 83%. That's nearly as much as what Denis Healey made Pete Townshend pay. Makes you wonder about the song, Won't Get Fooled Again. Looks like it was far from prescient.

On the other hand let's say you are an employer who is keen to increase productivity in her business. As part of this she needs to motivate her staff to work towards whatever goals are required to achieve this. The efficiencies available mean she has £100 per staff member to spend per month and it's judged that £100 would do the trick. There's a big difference between £17 and £100 so she thinks, I'll have to mitigate their losses in tax credits by increasing the incentive to make it £100 nett of tax, NI and tax credits.

My reckoning is that in order to achieve that £100 in net income per employee, for those in receipt of tax credits will cost the employer approximately £680 plus employer's NIC.

So it becomes undesirable for the employee to earn more and impossible for the employer to pay more. Productivity, social mobilty, low wages.

So regardless of the cost to the economy in cash terms, the cost in terms of the damage one to earnings, productivity and social mobility is reason enough to be deeply worried about the tax credit system.

The system is Labour's version of The Tory's right to buy legislation. A seemingly attractive policy with some dire consequences that it is pretty much impossible to do anything about.